Rand Capital Corporation

Greetings. Welcome to the Rand Capital Corporation Second Quarter 2021 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during a conference, please press star zero on your telephone keypad. Please note this conference is being recorded. I will now turn the conference over to your host, Deborah Pawlowski, Investor Relations for Rand Capital. You may begin.

Thank you, Jamali, and good afternoon, everyone. We appreciate your interest in Ram Capital and for joining us today for our second quarter 2021 financial results conference call. Here with me today are Pete Grum, our Chief Executive Officer, and Dan Penberthy, our Executive Vice President and Chief Financial Officer. You should have a copy of the release that crossed the wire this morning, as well as the slides that will accompany our conversation today. If not, they are available on our website at randcapital.com. If you are following along on the slide deck and would turn to slide two, I would like to point out some important information. As you are likely aware, we may make some forward-looking statements during this presentation and during the question and answer session. These statements apply to future events that are subject to risks and uncertainties, as well as other factors that could cause actual results to differ from where we are today. You can find a summary of these risks and uncertainties and other factors in the earnings release, as well as in other documents filed by the company with Securities and Exchange Commission. These documents can be found on our website or at sec.gov. During today's call, we will also discuss some non-GAAP financial measures. We believe that these will be useful in evaluating our performance. You should not consider the presentation of this additional information in isolation or as a substitute for results in accordance with GAAP. We have provided reconciliations of non-GAAP measures with comparable GAAP measures in the tables that accompany today's release and in the slides. So, with that, if you would turn to slide three, I will hand the discussion over to Pete to begin. Pete?

Thank you, Deb. Good afternoon, everyone. We continue to execute our strategy as we focus on evolving our portfolio from equity investments to income-producing investments. The goal of driving investment income and ultimately delivering higher cash distributions. For the quarter, our total investment income grew 20% to $811,000. That asset value per share of $22.51 was up 7% and 26% from the sequential first quarter and year-end period, respectively. The sequential increase largely reflects unrealized appreciation of our investment in open exchange following their equity financing by new non-strategic outside investors. The change from year end reflects the increase in fair value of our investments in ACV auctions, which completed their IPO at the end of March. During the quarter, we sold our investment in GiveGap, a software company that we've owned since 2015. Our equity investment of $616,000 netted us a recognized gain of $1.8 million. This is consistent with our strategy of transforming our portfolio from equity to debt. During the quarter, we accrued $1.1 million in non-cash expenses related to capital gains incentive fees, which were primarily the result of realized gains from the sale of GiveGab. and the increase in unrealized appreciation, mostly related to open exchange. The accrual will be adjusted on a quarterly basis. As a result, we reported a gap net investment loss of 31 cents per share. Absent this expense, adjusted net investment income was 10 cents per share. We announced and paid our regular quarterly dividend distribution of 10 cents per share during the second quarter. And at the end of July, we announced our third quarter dividend distribution, also at 10 cents per share. So far this year, we have declared $1.63 per share in dividends, including the $1.33 per share that was declared at the end of last year, but was paid in 2021. We turn to slide four. We can discuss the progress we have made regarding the evolution of our investment portfolio to support our strategy. The 14% increase in fair value shown here reflects the impact of open exchange, which now has a fair value of $5.6 million, an increase of $4.9 million during the year. The fair value of all of our investments increased by $7.5 million. At quarter end, our portfolio was comprised of approximately 55 percent equity investments, 36 in fixed-rate debt investments, and 9 percent in dividend-paying publicly traded BDCs. During the quarter, we made $4.6 million in new and follow-on investments and received $2.4 million from the one exit we discussed and the other loan repayments. These transactions are highlighted on slide five. The largest investment during the quarter was for ITA Inc. It totaled $3.9 million. $3.4 million consisted of 12% term notes and $500,000 was in equity. ITA manufactures a wide, broad variety of window covering components and finished wood treatments, including wood, full wood, and fabric shades, shutters, and blinds for residential and commercial applications. The follow-on investment was provided to Madison Avenue Holdings LLC, a high-end salon suite business that provides customized, fully furnished salon and spa studio space for lease and prime locations for individual stylists, barbers, massage therapists, nail technicians, and estheticians. This works as well as for other individualized services, such as acupuncture. Our 667,000 follow-on investors consisted of a 14% promissory note. In total, we now have $1.8 million invested in Madison at the end of the quarter. The charts on slide six illustrate the diversity of our portfolio and the change in industry mix since 2020 year end. With the investment we recently made, the impact of the investments and fair value changes, software and healthcare saw notable changes, while most of the other industries were within a point or so during that period. We like the diversity of our portfolio and believe it reduces our exposure to market risk. Slide seven lists our top five portfolio companies at quarter end. There are two new companies in the list. Open Exchange, which saw a measurable increase in its fair value, and ITA with a new investment. ACB's fair value came down about $1.7 million during the quarter, which followed the significant jump during the first quarter given their IPO. Their valuation in our portfolio represents 24% of net assets. Our ACB holdings consist of 147,645 Class A common stock and 442,935 of Class B common stock. The Class A shares are freely tradable while the Class B are still restricted and non-tradable through the September 20th, 2021. We have discounted our valuation due to these current restrictions. As a reminder, Any proceeds for us above our $163,000 initial investment will be a capital gain and traded as such as it relates to any dividend or distribution. With that, I'm going to turn it over to Dan to review our financials in greater depth.

Thanks, Pete, and good afternoon all. Slide 9 provides an overview of our financial summary and our operational highlights. Total investment income for the quarter was $811,000, a 20% increase over last year, and does reflect the shift in our portfolio profile to more interest yielding assets. In total, 23 portfolio companies generated income compared with 13 in the prior year period. This quarter's total investment income also benefited from approximately $137,000 of dividend income which was up 45% over last year's second quarter. This was primarily comprised of dividends received from our BDC investment portfolio. Total expenses in the quarter were $1.6 million, up from $476,000 in last year's second quarter. The change was largely due to the addition of $1.1 million of accrued capital gains incentive fees during the quarter, which Pete had already discussed. This incentive fee accrual was a result of the sale of GiveGap and the unrealized appreciation on open exchanges portfolio value. As a reminder, a capital gains incentive fee accrual under GAAP is calculated using the cumulative aggregate realized capital gains and losses and the aggregate net change in unrealized capital appreciation and depreciation at the close of the period. Operating expenses in the quarter, of which a non-GAAP financial measure excludes the capital gains incentive fee accrual, increased $84,000, or 18%, mostly because of the increase in the base management fee payable to Rand's investment advisor, resulting from the increased portfolio asset values. Net investment loss was $811,000, or 31 cents per share. Excluding the accrued capital gains incentive fees, adjusted net investment income per share was $0.10 compared with $0.08 per share in the prior year period. Even with the increase in expenses, net assets from operations increased $4.5 million or $1.74 per share. Slide 10 provides a waterfall graph for the change in NAV for the quarter. The increase was primarily due to the change in the fair value of RAND's investment in open exchange, which was reflected in the $3.5 million net change in unrealized depreciation on the portfolio investments. Also contributing to the NAV increase was a net realized gain on the sale of GiveGab, which Pete had discussed. We also paid out approximately $260,000 of cash dividends. Slide 11 highlights the strength of our balance sheet. We have approximately $16 million in liquidity for new investments. This does include $3 million of availability for borrowing under our SBIC debentures. The $10.8 million currently owed to the SBA matures over a long multi-year period. However, that begins next year in September when $3 million is due. As required to maintain our RIC status, We will continue to distribute at least 90% of our calendar year qualified income to our shareholders in the form of dividends. Our annualized dividend rate of 40 cents is based off our initial conservative estimates of our 2021 net investment income and is reviewed quarterly based on our actual year to date gap and estimated tax results. Later in the fourth quarter, We will then review all sources of GAAP and tax-based income, including those from short and long-term capital gains, which may result in additional 2021 distributions over the previously distributed regular quarterly cash dividend estimates. The final determination and calculation of our tax-based distributable income for each year is finalized in September of the following year in conjunction with our corporate tax return filings. This is commonly referred to as a spillback dividend. Our current share repurchase program authorizes the purchase of up to $1.5 million in stock and expires next year in April of 2022. We did not repurchase any stock during the second quarter. As we look forward, with the support of our strong liquidity position, We believe we can continue to execute our strategy to grow our portfolio, drive investment income, and support a growing dividend. That completes our prepared remarks. Operator, please open the lines for questions.

And at this time, we will be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star, too, if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Our first question is from Sam Hrabowski with SER Asset Management. Please proceed with your question.

Yeah, good morning, Pete and Dan. The ACVA, which is currently valued at $23.62, what was the value on June 30th that we used?

It was, well, we wrote it down, $1.7 million. And some of that was due to changes in the market value, and some of that was changes in the discount that we used because of lack of... because of lack of saleability at the time.

Sam, the Class A at June 30 was $24.85, and the Class B was $23.61. Okay, thank you. So of the $1.6 million capital gains that we paid, $3.6 million,

How much is that attributable to the ACVA?

Well, I don't think we've paid anything. We've accrued.

Accrued, right. Okay. What amount that we accrued would you say is attributable to the ACVA?

I can't do that out of my head, but I'll certainly get back to you.

Sam, I think you're maybe mixing up a couple items here. The $1.6 million of the gains, those were primarily driven off give-gave. So of the realized gains, I'm sorry, there is a capital gains incentive fee, which was $1.6 million, which was accrued on the quarter. Most of that is attributable to unrealized appreciation on open exchange and also some offset by the depreciation, actually, in ACV during the quarter. Because if you remember, we had ACV valued at $26.79 at the end of the March 31st quarter, and that was adjusted downward based on their closing stock price at June 30 to the $24 numbers that Pete had mentioned.

Okay. And the $3.6 million?

That includes the net... That is the total capital gains incentive fee if, in theory, the portfolio were to liquidate at its closing values at June 30 based on the realized gains and losses, unrealized activity.

Okay, okay. So are we happy? Do we have another ACVA in our portfolio?

Sure, of course we do, Sam. All right.

Sam, the portfolio is mark-to-market quarterly, and those are the corporation's estimates of what the fair value is at that time period. We can't get out the crystal ball and tell you where things will end up on September 30, 2021, much less where they're going to be two, three, or five years down the road.

Okay. When the stock ran up, 26, 27. What was that attributable to?

We were not responsible for that. We didn't have any news in there. It's happened periodically during my life here. You have a thinly traded stock and people start talking about it, but we don't have any idea. There was certainly, we talked to NASDAQ surveillance, there was no information that we put into the market. So I don't know, Sam, but I didn't get any calls prior to that or after that.

Yeah, yeah, yeah. Okay. I heard somebody attributed you to another Warren Buffett stock, Berkshire Hathaway. Did you hear those rumors?

No.

No. Okay. All right. Well, good luck, guys.

Thanks, Sam. We appreciate your support.

And our next question is from Brett Davidson, who is a private investor. Please proceed with your question.

Good afternoon. I hope you guys are inside today.

We are.

And forget about whether you heard the rumors. Are they true?

You mean that I'm the next Warren Buffett?

There you go. That's the important answer I want to hear. Is it true? I got a couple of questions. So, you know, I heard in the presentation and tried to take it all into account as far as adjusting the dividend. And So it looks like yearly it's going to be done after the close of the year. Any adjustment would be done later the subsequent year. How will that play into adjusting the quarterly dividend? Or are most of these adjustments going to be done on a one-time special sometime later in the subsequent year?

I'll answer it as I thought I heard it. Quarterly dividend, we believe, is designed on a conservative basis to match our net investment income of what we see in the future. And we forecast out and look at that. And the board and the management company analyze that to make sure it's a sustainable dividend. And the hope is that that'll grow over time. I'm going to turn it over to Dan to talk about the work that goes through because on the capital gains, because that's also on a tax basis as most of this is. So there can be some differences and differences in timing.

Yeah, so at the beginning of the year, we project out what we think we're going to happen for the year based on our investment portfolio. Since we are in a debt portfolio, we do experience more debt repayment, which often happens unexpectedly. which does have a negative effect to deterioration of our income, obviously. And so we monitor that quarterly and we prepare an analysis and determine where we think the year will end up. And then so that is done each quarter. And then as we get to the fourth quarter, we'll then tighten those numbers down as we prepare an initial tax estimate based on our actual projected results for the for the full calendar year 2021. As Pete mentioned, those will have two components. The first will be a capital gains component, which will be more kind of just a one-time type dividend annually, because that's based on capital gains, net capital gains offset by losses, obviously, that we may have had. And then we also look at operating income for the year, and we do an initial tax calculation with our third-party tax advisors trying to get as precise a tax model as you can on your income because we strive to make sure we distribute out at least 90 percent of our income on a during the calendar year or in the immediately January following the conclusion of the year and all that is attributable to 2021. Then what happens is when the final tax returns are done hopefully we've done our job well enough with our outside advisors that there's minimal adjustment that's needed for 2021 on a tax basis based on our final tax return calculations. And that work will be done as being done currently with an expectation of our tax returns being filed typically in September. And that is what I referred to as that spill I want to make sure I refer to it, spill back dividends. And we would think that would be a minor amount, but we don't know until we're to the conclusion of the tax returns. And that would be included as a one-time adjustment to this upcoming quarter's tax numbers. This is now the first time through all these RIC calculation process on a tax basis. So some of this is still subject to change, but that is the fundamental thesis Well, we look at it quarterly, we tighten it down in December for the calendar year, and then we go back and proof our numbers in August and September to see if there's a plus or minus adjustment that needs to happen for tax purposes.

My particular interest is in how that's going to be paid. So capital gains, that's going to be a one-time thing. So say that the estimate for the income that was used to base that $0.10 quarterly dividend is wrong by a dime. So is that going to result in a one-time $0.10 dividend, or is that going to be spread over the subsequent year's quarterlies?

I believe that it has to be paid during that year, or else you lose your RIC status. So it would be paid and it's not spread over the next year.

Yeah, I don't believe it would be spread. However, again, I will stress again that, uh, this is in consultation with our third party, Rick tax advisors. Uh, and so, uh, need to take that into consideration, but I also believe it would be a one-time adjustment to the dividend and the board election can determine whether that be a cash stock or other form distribution.

Well, I would think it would need to be a cash, wouldn't it, if it requires the distribution of the earnings?

You can do cash, or you can do a combination of cash and stock with some limitations.

There's minimum cash requirements that have to go out, but that is also to be discussed at the board level on a quarterly and annual basis.

All right, so correct me if I'm wrong here. So then the dividend for the subsequent year will be set prior to that year, and it'll result in an up or down adjustment in the quarterly dividend. And then for this spillback and any capital gains, those would ordinarily result in one-time dividends.

Yeah, it would be an adjustment to the third quarter dividend, most likely.

Okay, so it'll be adjustment to one quarter's dividend then. Got it.

But we'll differentiate when we... That's right. Yes, we'll make it very clear this is the regular quarterly dividend.

Here's our 10 cents plus whatever the adjustment is.

Got it.

This is the 10 cents we just issued in July. Here's 10 cents plus the extra amount or we have to offset... the number because the real number for last year was, you know, make up, you know, subtract a penny. You know, we don't know what the number is until the final tax calculations are answered.

Yep, understood. Next question I'm interested in, is there any kind of exit strategy for ACV?

Yes, and we highlight, we look at that with our liquidity, upcoming needs, where we think the price will go, kind of our own little algorithm that we have. But yes, we are not in the business of owning public shares. And I think over time, as we have historically done, we will exit.

So you said over time, that means this isn't like an all or none operation here.

Of course, you wouldn't want us to give you insider information, would you?

No, no, no. I'm just talking about the character of the transactions. I'm not looking for specifics regarding timing.

Well, yeah. So here's our goal is to take equity investments like that, liquefy them, convert that cash into interest-paying debentures or loans or

you know a variety of other things so that we can increase our goal is to increase our ongoing dividend and part of that is changing equity into debt yeah and so i mean from the all or none perspective i mean this isn't going to be we're going to decide we're going to exit acv and it's going to happen you know over the course of a day or a couple days this this could be uh A period that, you know, runs from, you know, beginning of one year to the end of the next. Is that fair characterization?

I'm uncomfortable characterizing it either way. You know, we own 500,000 shares. It's a $4 billion company. It'll be based on our alternatives to put the money out, where we think the price is. compared to where we think it should be.

All right. Let me rephrase it. Is there a certain time period that this has to occur over? Is there an end date that this has to occur by?

No.

Okay. So this could conceivably take place over a period of time and not necessarily once you decide to sell, it has to be completed within a week or whatever. Okay. Are you aware of any other investments that are currently looking to take advantage of the atmosphere in the public equity markets? Is there anybody that you've got feedback from that's looking to maybe do an IPO? or something you guys wouldn't ordinarily be privy to.

Well, we wouldn't disclose it in a conference call.

Got it.

And my last one is I'm looking, is there, can you give some clarity as to what the transaction was that precipitated the sale of the GiveGab position? Was it something that they did or you guys were just able to find a buyer for your investment?

Well, the company sold in totality and that was our proportional. That's our proportion that we received. As you can imagine, COVID hits each company a little bit different. They were in the business of online fundraising, and they had been having a nice trajectory of growing anyway, but they were in a nice spot and had a number of opportunities to provide liquidity, and they picked this one until the whole company was sold.

Is that information available online, or can you give some idea what that transaction involved? Was it private equity?

It was acquired by – it is all available online. If you just Google, you know, GiveGab and do a search, every action acquires – this is April 15th from the nonprofit time. Just Google it as you're on the phone. Every action continues shopping acquires GiveGab. No transaction price was disclosed, but I'm sure if you – You're a sleuth. You can find out a lot.

Yeah. Yeah, I think I could probably figure that one out. So thanks much. I appreciate it. And that's pretty much all I have. Thanks, guys.

Thank you, Brad.

And as a reminder, if you have any questions, you may press star 1 on your telephone keypad. This way you do enter the question and answer queue. Our next question is from Ross Haberman with RL8 Investments. Please proceed with your question.

Hello, gentlemen. Nice quarter. Just two follow-up questions about ACV. I got on a little late. If I understand right, you have about 353,000 of the B shares currently?

I'm going to tell you that approximately... I'm going to tell you exactly. We have 147,645 shares of the Class A and 442,935 of the Class B. When can you register the B to sell? I believe that B sales will become freely tradable after September 20th. Okay. And if I...

Excuse me, Ann, if I understood it right, you marked the whole position of roughly, I don't know, $23.50 or $24 as of the end of the quarter. Is that correct?

We marked them using the last three trading days of the quarter. The Class A, we don't have any discount because it's freely tradable. Class B, we have a 5% discount to reflect the restrictions.

I see what you're saying. And both those marks total your $14 million carrying value at the end of the quarter?

Yes, sir.

Got it. Okay. That was all my questions. Thanks again.

Operator?

We have reached the end of the question and answer session. I'll now turn the call over to Pete Grum for closing remarks.

Thank you very much, and thank you for joining us today and for your interest in RAND Capital. We look forward to updating all of you on our third quarter 2021 results in November, and have a great day.

This concludes today's conference and you may disconnect your lines at this time. Thank you for your participation.